Arbitration Under Fire: Brace Your Company for Less Contract Freedom and More Class Actions

By: George Calhoun

Since the Federal Arbitration Act (FAA) of 1925, the United States has had a policy preference for arbitration, even when an arbitration provision includes language barring class action litigation.  We saw this most recently in December 2015 when the Supreme Court reversed a decision by a California Court of Appeal to invalidate a class-arbitration waiver within a service agreement between DirecTV and its customers.[1]  But not everyone thinks arbitration is so great a thing.  Encouraged by consumer groups and trial lawyers, federal regulators are pushing for limits on arbitration provisions in consumer contracts.

At its core, the debate is about whether companies may compel consumers to arbitrate rather than litigate disputes and – perhaps more significantly – bar consumers from class action remedies as part of the arbitration requirement.  Critics of mandatory arbitration say that it restricts consumer redress and is tantamount to a deceptive trade practice because the arbitration provisions are usually contained in the “fine print” of a contract.  The new rules being proposed reportedly are designed to eliminate mandatory arbitration provisions and facilitate class action litigation.

Despite the criticisms of consumer groups, arbitration often is cheaper and more effective for both individual consumers and companies.  By interfering with Americans’ freedom of contract to prevent the use of mandatory arbitration, the government could severely damage U.S. business interests by exposing them to a marked increase in expensive class action litigation.  In turn, that would result in more limited choices and increased costs for consumers.

The government’s efforts to eliminate mandatory arbitration provisions in consumer-related contracts have been highlighted in several recent agency actions.  In its list of near-term goals, the Bureau of Consumer Financial Protections (CFPB) said that new rules to govern arbitration in consumer contracts would be a priority in 2016. The Department of Education announced that it, too, was reviewing mandatory arbitration provisions in college enrollment contracts.  And despite multiple appellate decisions to the contrary, the National Labor Relations Board (NLRB) again concluded that class action waivers in arbitration agreements infringe on an individual’s rights under Section 7 of the National Labor Relations Act.

All of this has happened in the space of three months, indicating a clear effort by the government to diminish businesses’ ability to require arbitration that shields them from often frivolous and costly class action litigation.  The acts of some Congressmen have made this agenda even more transparent.  In February 2016, Senator Patrick Leahy introduced a bill that would modify the scope of the FAA and curtail the use of mandatory arbitration.  The bill is unlikely to pass in the current Republican Congress, but Congress previously empowered federal agencies to curtail the use of mandatory arbitration provisions on a significant, but more limited, basis.

The CFPB’s current actions were authorized by the 2010 Dodd-Frank Act[2], which barred the use of arbitration clauses in certain mortgage contacts[3] and gave the SEC power to ban or restrict the use of arbitration in other disputes. Deepak Gupta, then the CFPB’s senior counsel for enforcement strategy, stated that prohibiting or restricting mandatory arbitration would be “the single most transformative thing the bureau can do” for consumers.[4]  In March 2015, the CFPB released a 728-page study of arbitration in consumer contracts, which was criticized by some academics and trade groups for misstating the impact of mandatory arbitration provisions on consumers.  Since then, members of Congress have engaged in deeply partisan squabbling over the need for additional rulemaking on consumer arbitration or to limit class action litigation in other ways.

Despite the criticism and opposition, CFPB director Richard Cordray reiterated the agency’s plans to release new rules aimed at banks and other financial firms. Earlier comments by the agency confirm that the new rules will be designed to prevent arbitration clauses from restricting class action remedies.  We think such changes would quickly spread to encompass telephone, Internet, and other commonplace consumer agreements.

American companies should be concerned with how executive agencies, e.g., the CFPB, the Department of Education, and the NLRB, will carry out their plans to introduce regulations that restrict the use of arbitration clauses in a broad range of consumer contracts.  We will not be surprised to see some companies restrict their consumer offerings or increase prices to account for these new rules.  If you work in American business, we urge you to take notice of these changes and review how to protect your company from undue litigation in future contracts. Among other options, you should analyze the inclusion of non-mandatory arbitration provisions, the separation of class-action waivers from arbitration provisions, and the option of raising prices to contend with increased litigation.

[1] DIRECTV, Inc. v. Imburgia, 136 S.Ct. 463 (2015).

[2] Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (2010). The Dodd-Frank Act was passed without a single Republican vote in the Senate.

[3] Id. § 1414.

[4] Carter Dougherty, CFPB Finds Arbitration Harms Consumers, Presaging New Rules, BLOOMBERG BUS., March 10, 2015, available at http://www.bloomberg.com/news/articles/2015-03-10/cfpb-finds-arbitration-harms-consumers-in-study-presaging-rules.